What with all the attention to hostile pharma deals these days, it's no surprise that names of potential targets are getting batted around in the press. This was interesting, though. A name of a firm that is not a target - Eli Lilly. Why? Because Eli Lilly is an Indiana corporation and Indiana corporations are subject to that state's control share statute. This flavor of state antitakeover prevents an acquiring shareholder from exercising the voting rights over any "control shares" without the express approval by the other shareholders of the target corporation. This particular type of antitakeover decision was approved by the US Supreme Court in CTS Corp as not pre-empted by the Williams Act and within the competence of state legislatures. Though largely superceded by Section 203, later generation antitakeover statutes, the control share statutes are still out there and they are potent defenses.

The typical M&A confidentiality agreement contains a standstill provision, which among other things, prohibits the potential bidder from publicly or privately requesting that the target company waive the terms of the standstill. The provision is designed to reduce the possibility that the bidder will be able to put the target "in play" and bypass the terms and spirit of the standstill agreement.

In this client alert, Gibson Dunn discusses a November 27, 2012 bench ruling issued by Vice Chancellor Travis Laster of the Delaware Chancery Court that enjoined the enforcement of a "Don't Ask, Don't Waive" provision in a standstill agreement, at least to the extent the clause prohibits private waiver requests.

As a result, Gibson advises that

until further guidance is given by the Delaware courts, targets entering into a merger agreement should consider the potential effects of any pre-existing Don't Ask, Don't Waive standstill agreements with other parties . . .. We note in particular that the ruling does not appear to invalidate per se all Don't Ask, Don't Waive standstills, as the opinion only questions their enforceability where a sale agreement with another party has been announced and the target has an obligation to consider competing offers. In addition, the Court expressly acknowledged the permissibility of a provision restricting a bidder from making a public request of a standstill waiver. Therefore, we expect that target boards will continue to seek some variation of Don't Ask, Don't Waive standstills.

Like many other states, Massachusetts has recently passed an amendment to its corporate law that permits the incorporation of "Benefit Corporations" (Chapter 238, Section 52). I have opinions about whether this is anything more than just a marketing effort, but let me put those to the side for the time being. Here, I'd like to focus on the fact that the Secretary of State of the Commonwealth of Massachusetts apparently has a tenuous grasp on what the corporate law of Massachusetts presently is. In the Commonwealth's official notice and FAQ for Benefit Corporations, the Corporations Division describes the need for Benefit Corporations, thusly:

What are benefit corporations?

Benefit corporations are corporations organized under Chapter 156A (the professional corporation statute) or Chapter 156D (the business corporations statute) that have elected to be a benefit corporation in their Articles.

Benefit corporations are similar to traditional for-profit corporations but they differ in one important respect. While directors and officers of traditional for-profit corporations must focus primarily on maximizing financial returns to investors, the directors and officers of benefit corporations are expressly permitted to consider and prioritize the social and environmental impacts of their corporate decision-making.

For example, the directors of a traditional for-profit corporation faced with financial difficulty may opt to build up cash reserves by laying off employees in order to fulfill their fiduciary duty to prioritize returns to investors. A benefit corporation's directors faced with similar economic circumstances could prioritize retaining the corporation's workforce through hard times, opting to dip into cash reserves to do so, in order to pursue the corporation's public benefit goals.

Or ... the board of a for-profit corporation could simply decide to not lay-off employees and not face any repercussions from shareholders for a decision (not to lay-off workers when times are tough) that already is well within their rights.

I've written on this before in the context of state anti-takeover laws. Constituency statutes were adopted here in the Commonwealth during LBO boom to help give directors the power to resist unwanted offers. Currently, the directors of a Massachusetts corporation can put "shareholder maximization" behind the interests of employees, suppliers, creditors, whatever. Here's 156D, Sec. 8.30:

Section 8.30. GENERAL STANDARDS FOR DIRECTORS

(a) A director shall discharge his duties as a director, including his duties as a member of a committee:

(1) in good faith;

(2) with the care that a person in a like position would reasonably believe appropriate under similar circumstances; and

(3) in a manner the director reasonably believes to be in the best interests of the corporation. In determining what the director reasonably believes to be in the best interests of the corporation, a director may consider the interests of the corporation’s employees, suppliers, creditors and customers, the economy of the state, the region and the nation, community and societal considerations, and the long-term and short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.

So ... a director of a MA for-profit corporation is presently under no legal obligation to put the maximization of short-term shareholder value/returns over interests towards constiuencies of the corporation, like employees. It's true that constituency statutes were originally adopted as anti-takeover statutes and they still play that role. But, for a publicly minded corporate board, the constituency statutes in place already provide plenty of legal cover to pursue public benefit in the corporate form.

I'll have more to say on Benefit Corporations later. For now, I am wondering whether Benefit Corporations might be a back door into supercharged state anti-takeover protections for firms that opt in? I don't think it's necessary, but lawyers have been known for pursuing belt-and-suspender defenses.

As part of its hostile effort to acquire Pharmerica, last week Omnicare filed suit against Pharmerica and its board. Here's the Omnicare - Pharmerica complaint. Now, let me state right up front that I don't think this suit falls into the more general category of litigation flotsam that accompanies many merger announcements these days. Although this is acquisition-related litigation, it involves a purported acquirer attempting to have the target's board withdraw its defenses against the offer. This case is more along the lines of the Airgas scenario. In any event, given Airgas, one wonders whether Omnicare thinks it can pull an Omnicare-styled rabbit of the litigation hat. And why not? It happened famously for them once before.

In any event, the first defense that Omnicare would like the court to order withdrawn is Pharmerica's pill. It's hard, given Airgas, to come up with a reasonable justification for the court to order Pharmerica's board to pull its pill. Maybe after a year or trying, but now? Probably not. Omnicare's argument that Pharmerica's board is violating its fiduciary duties by not negotiating with Omnicare is going to fall flat. The requirement is that Pharmerica's board be informed. There is no requirement that it negotiate to sell its company to an unwanted bidder. Of course, this is complicated by the fact that early in the summer, Pharmerica's CEO approaced Omnicare's CEO to discuss a possible combination, but that's just a complication. Omnicare doesn't present any evidence to seriously suggest that Pharmerica's board is uninformed about its decision not to engage with Omnicare.

Second, Omnicare would like the court order Pharmerica's board to adopt resolutions exempting Omnicare from the effects of DGCL 203. Yikes. Omnicare's argument is essentially that Pharmerica's board is violating its fiduciary duties to the corporation by not actively exempting an unwanted bidder from Delaware's antitakeover statute. Absent egregious facts that aren't present in the complaint, I can't imagine a court taking that argument all that seriously.

I've written on this before (and also here, and here). In the 1980s during the great takeover boom and hollowing out of the industrial heartland, many states adopted amendments to their corporate codes that codified directors' fiduciary duties, so-called "constituency statutes". In general, these provisions made it clear that a director need not "maximize shareholder value." Rather, in complying with their fiduciary obligations, directors may take all sorts of things into consideration - the impact of their decisions on various constituencies, including employees, the community, the environment, the color of the sky, whatever.

When these statutes were first passed, they were heralded as way to protect jobs, etc. Earlier this year, Michigan passed one hoping it would protect local jobs from corporate raiders. Lots of other states have similar constituency statutes. For example, Oregon has one (Sec. 60.357). You can find them all over. In general, these statutes reject Unocal and Revlon as binding on directors of corporations in those jurisdictions.

My problem with these statutes is that they strike me as a bit of a head fake. While they certainly give boards the power they need to protect local communities, etc should they so desire, they don't actually require directors to protect those constituencies. In effect, such statutes, simply give directors another fiduciary lever to pull when negotiating with a potential acquirer.

I've said this before, but you know a board might be very concerned about the impact of a potential acquisition on employees and the community when the bid is $69. At $75, the board's concerns about the impact on the community might start to fall away. Why not move the HQ to Paris? It's so much nicer there than Cambridge. At $85? Employees ... we have employees?!

There's no requirement that a board share the incremental price increase with those stakeholders who will lose out when a transaction is ultimately done. Does anyone really think that a board, having invoked this provision to say no, will then turnaround a cut a check to the local community the day after it accepts an offer to sell? In the end, the price paid goes to shareholders, not to the employees or the community or the environment. To the extent these statutes get sold to legislators as important tools to protect local companies (and jobs and communities) from outside raiders, they are, in that sense, a bit of a scam. These statutes put all the cards into the hands of directors. And that's fine, if that's what you want to do.

Along those lines, I spent the afternoon in the MA Business Litigation Session yesterday with a couple of students. We went to observe motions being argued in the consolidated case against Genzyme. You'll remember that Genzyme and its directors were sued (8 lawsuits!) after they turned down a friendly merger proposal from French Sanofi (this is before Sanofi went hostile).

In their complaints, the plaintiffs made a variety of allegations of the sort you might expect - by not accepting or negotiating the offer from Sanofi that the board violated is fiduciary duties to "maximize shareholder value" [Revlon], etc. Here's the thing, though. Massachusetts has a constituency statute (156D, Sec. 8.30).

Section 8.30. GENERAL STANDARDS FOR DIRECTORS

(a) A director shall discharge his duties as a director, including his duties as a member of a committee:

(1) in good faith;

(2) with the care that a person in a like position would reasonably believe appropriate under similar circumstances; and

(3) in a manner the director reasonably believes to be in the best interests of the corporation. In determining what the director reasonably believes to be in the best interests of the corporation, a director may consider the interests of the corporation’s employees, suppliers, creditors and customers, the economy of the state, the region and the nation, community and societal considerations, and the long-term and short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.

So, here come the shareholders with the extremely premature claim that Genzyme's directors somehow violated their fiduciary duties to the corporation because they turned down an unsolicited offer from Sanofi. But, Genzyme is a MA corporation and MA is not Delaware. If the directors act in good faith, and then come to the determination that it's in the best interests of the corporation and the city of Cambridge for Genzyme to stay independent, no court in MA will disagree with them. The plaintiff shareholders simply have no case because (so far) the constituency statute is working exactly as intended.

I think this is interesting, because just as labor, community, etc. have no case to prevent a sale notwithstanding the presence of a constituency statute, neither do shareholders have a voice to push one. The directors call the shots. I often wonder, other than directors, what constituency these constituency statutes serve.

Abstract: During the 1980s, many states adopted statutes intended to regulate corporate takeovers. The Supreme Court validated one of these statutes, The Indiana Control Shares Acquisition Statute, in CTS Corp. v. Dynamics Corp., 481 U.S. 69 (1987), against both preemption and commerce clauses challenges. Since CTS, state takeover laws have routinely withstood constitutional scrutiny, even though it is generally acknowledged that, by erecting new barriers to hostile tender offerors, they make tender offers less attractive. At the time this article was published (1992), proxy contests were becoming an increasingly important component of hostile takeover battles. Today, of course, proxy contests and various other forms of shareholder activism have become a common feature of the corporate governance scene. This article considered whether state laws designed to regulate proxy contests would withstand constitutional scrutiny. It surveys whether such laws would be preempted by the federal proxy rules or the Williams Act’s tender offer regulations. It also briefly touches upon the Commerce Clause aspects of any such challenge. The article concludes that state regulation of proxy contests should withstand constitutional challenge.

The papers are worth reading side by side to get a good overview of the question of constitutionality of state anti-takeover laws.

The bill (Senate Bill 1174) requires that any acquisition of a domestic (Michigan) insurer with less
than 200 employees would require the "approval " of at least 66.67%
of the shareholders if the proposed transaction is not approved by the board of
directors. Initial query - how is it that shareholders are supposed to
"approve" an acquisition agreement that has not been approved by the
board? Unless the new law includes a requirement that board sign merger
agreements that they don't approve of, the only way for shareholders to
"approve" of a hostile transaction is by tendering their shares. Oh ... and the bill purports to make it illegal for any person to make a tender offer for the shares of a domestic insurance company if such tender would result in a change of control! Thanks always for the small things: theHouse
version of this bill sunsets the legislation on May 1, 2012.

Myproblem with these kinds of efforts, other than them being vanity pieces, is that they are
often touted as pro-employment/pro-community laws and supported by both labor and community leaders. The truth is, though, they are not.
You know - the buyer will lay everyone off and give nothing back to the
community - that kind of thing. For example – here’s aletter
to the editor of the Detroit News making just that argument with respect to
this bill.

But nothing in the law
requires the board to do anything for labor or the community. Indeed, I suspect that at the right price the
board of a target Michigan
firm subject to this law might be happy to do a deal. But,
there is no requirement in the law that the board in doing a transaction seek guarantees of employment for labor or seek commitments from the buyer that it remain in the community. In effect, all these legislative efforts really do is give
managers an additional lever to negotiate a better deal for shareholders.

If legislators think they are passing these
laws to protect local communities and jobs, they should guess again. America’s Rust Belt is littered
with efforts like these.

I have been giving some thought to how jurisdictions other than Delaware deal with the question of intermediate scrutiny. Although Delaware leads the way in the M&A jurisprudence, other states have gone their own way in important respects. One of them is the hesitance of other states to adopt the Unocal, or intermediate scrutiny, doctrine in the context of board responses to takeovers.

I think I understand why and how things developed this way. It's an old story. The 1980s LBO boom was a scourge for management. They used whatever tools at their disposal to prevent an acquisition, lest they be shown the door by new management. The Delaware courts stepped in to put a limit on unreasonable and draconian defenses. In short, the message from the courts was that boards did not have a free hand to put off all takeover attempts. There were limits, albeit not always binding.

Politically, I suppose it was okay for Delaware to take that position. Other states, particularly in the Rust Belt, took another view. For them the LBO meant nothing but massive unemployment and dislocation. They responded by providing management tools to keep potential acquirors at bay, including writing fiduciary standards into their codes. This is something Delaware has never done. These standards often include constituency language: a director's actions to consider the impact of a board's actions on the corporation's various constituencies won't be inconsistent with a director's fiduciary obligations to the corporation. Of course, nothing really prevents a director in a Delaware corporation from making the same considerations, but I'll come back to that later.

In any event, Ohio has what I think is a pretty typical constituency provision (GCL 1701.59):

(E) For purposes of this section, a director, in determining what the director reasonably believes to be in the best interests of the corporation, shall consider the interests of the corporation’s shareholders and, in the director’s discretion, may consider any of the following:

(1) The interests of the corporation’s employees, suppliers, creditors, and customers;(2) The economy of the state and nation;(3) Community and societal considerations;(4) The long-term as well as short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.

Now, that's pretty management friendly language. The interests of shareholders always have to be considered and in the director's discretion other interests can be weighed against that, just in case the interests of the shareholders and other constituencies don't entirely mesh. This isn't inconsistent with the liberty that a Delaware director is given to consider all sorts of factors before the corporation undertakes an action. That's the value of the business judgment presumption.

Oregon takes the constituency language a step further and is more explicit in its application (60.357):

(5) When evaluating any offer of another party to make a tender or exchange offer for any equity security of the corporation, or any proposal to merge or consolidate the corporation with another corporation or to purchase or otherwise acquire all or substantially all the properties and assets of the corporation, the directors of the corporation may, in determining what they believe to be in the best interests of the corporation, give due consideration to the social, legal and economic effects on employees, customers and suppliers of the corporation and on the communities and geographical areas in which the corporation and its subsidiaries operate, the economy of the state and nation, the long-term as well as short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation, and other relevant factors.

Message to directors: don't be afraid to say no to an unfriendly offer and rationalize that by saying the offer would be bad for the local community or environment. This kind of language makes a poison pill unnecessary. This is very management friendly language. I wonder why there aren't more Oregon corporations?

Indiana takes it to the extreme. Indiana makes it clear that the Delaware approach -- that places limits on director discretion in certain circumstances goes too far. Indiana disclaim intermediate scrutiny entirely and in a rather straightforward manner (IC 23-135-1):

Certain judicial decisions in Delaware and other jurisdictions, which might otherwise be looked to for guidance in interpreting Indiana corporate law, including decisions relating to potential change of control transactions that impose a different or higher degree of scrutiny on actions taken by directors in response to a proposed acquisition of control of the corporation, are inconsistent with the proper application of the business judgment rule under this article. Therefore, the general assembly intends:

(1) to reaffirm that this section allows directors the full discretion to weigh the factors enumerated in subsection (d) as they deem appropriate; and (2) to protect both directors and the validity of corporate action taken by them in the good faith exercise of their business judgment after reasonable investigation.

Business judgment forever!

One thing is clear, I think. These constituency statutes don't exactly do the work that legislators probably hoped they'd do when they were originally passed. While such provisions might protect some constituencies, they leave discretion with management and, consequently, add to the tools management can rely on to resist offers in the event management wishes to entrench itself.

Worse, from the point of view of constituencies, what if management simply uses the constituency provision to negotiate a better deal for itself without regard to the constituency at issue. For example, if a rust belt company is approached with an offer to go private at $21, it could well respond, "I'm sorry, but at $21, this deal is not good for our employees, the local community or the environment." Imagine the surprise of constituencies when at $25, the board changes its mind, and takes the offer. In the end, the only constituency with standing is the shareholder community. Consequently, one shouldn't be surprised if/when directors use these statutes as little more than bargaining levers at the expense of the communities they were meant to protect.

Of course, if legislators were to give the various constituencies the same standing in courts as shareholders, I might come to a different conclusion.

The real question regarding the shareholder
access debate is whether once shareholders have the power to nominate
minority directors whether they will use it for good or ill, or at all.Yair Listokin has a paper, “If You Give
Shareholders Power, Do They Use It? An Empirical Analysis,” in which
suggests the answer might be that they won’t use it at all.Listokin looked at state antitakeover
protection statutes that provide shareholders with the opportunity to opt-out
through the adoption of shareholder initiated bylaw proposals.He finds that very few companies’
shareholders take advantage of the opportunity to opt-out of these
statutes.This finding is consistent
with earlier work from Rob Daines and Michael Klausner who looked at customization of
incorporation documents and found very little opting out of default provisions
(here).

Recently, we started to have experience with shareholder
votes relating to ‘say-on-pay’ a hot-button issue
(and here) it
there ever was one.So far,
shareholders who have had the opportunity to vote on pay packages appear
reticent to say ‘no.’The WSJ recently
canvassed 15 companies large cap companies with say-on-pay policies that permit
shareholders to review executive pay policies (here) and none
of questions passed.Given the high
degree of emotion that pay questions can generate, the vote results (or lack of them) are pretty
amazing. All of this simply provides
fuel for the shareholder access debate.

In this case, Ventana was incorporated in Delaware but headquartered in Arizona and had substantial assets in that state. Arizona's third generation anti-takeover law, the Arizona Anti-Takeover Act, purports to cover Ventana since it has a substantial presence in the state. Roche sued in federal district court to have it declared unconstitutional and requested that enforcement of the statute be preliminarily enjoined. In granting this motion, the federal court found Roche to have a substantial likelihood of success on the merits because the statute applied to corporations organized under laws of states other than Arizona. Here the Court found that:

there is strong authority demonstrating that the Arizona statutes violate the Commerce Clause because the burden on interstate commerce “is clearly excessive in relation to the putative local benefits” to Arizona. In this case the burden on interstate commerce created by the broad application of Arizona statues includes the frustration and regulation generated by a tender offer made to a foreign corporation, such as Defendant. While Arizona clearly has an interest in protecting businesses that have significant contacts with Arizona, such as Defendant, Arizona clearly has “no interest in protecting nonresident shareholders of nonresident corporations.” In balancing such competing interests, the interference with interstate commerce created by the regulation of a foreign corporation controls. The instant case, based upon the Arizona statutes and their application to foreign corporations, is no different than the cases presented above as the Arizona statutes, while protecting businesses with significant contacts with Arizona, unreasonably interfere with interstate commerce based upon the regulation of businesses that are not incorporated in Arizona.

(citations omitted). The Court distinguished the Supreme Court's decision in CTS on the following grounds:

In CTS Corp., the Supreme Court upheld the constitutionality of Indiana’s Control Share Acquisition statute, which would impact the voting rights of an acquiring corporation in the event of a takeover of a target corporation, largely because the Indiana statute applied only to corporations organized under the laws of Indiana.

Thus, the difference for the Court here was the situs of incorporation for Ventana outsdie the state of Arizona. This opinion is therefore a strong statement in support of the internal affairs doctrine and should make life easier for M&A lawyers by more strictly confining the application of state takeover laws to companies organized in the state of their origin (although other federal cases from the '80s have held similarly - nice to know we are not going the other way though). And for those who engage in the race-to-the-bottom/race-to-the-top state corporate law debate, the case is a probably a good example of the need for a mediating and trumping federal presence in this debate. Here, I'll relate the historical tidbit that the Arizona Anti-takeover Law was initially proposed in 1987 by officials of Greyhound Corporation who claimed that they were the target of a hostile takeover.

Nonetheless, Ventana still can rely on its Delaware defenses including that state's business combination statute (DGCL 203) and the poison pill it has adopted. To be continued.